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Agenda. Collect reaction papers multiple choice questions class participation forms for day 3 (Tuesday) Discuss Sunder Lev SEC readings. Spreads. What’s a spread? the difference between the bid (buying) and ask (selling) prices set by the market maker.

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agenda
Agenda
  • Collect
    • reaction papers
    • multiple choice questions
    • class participation forms for day 3 (Tuesday)
  • Discuss
    • Sunder
    • Lev
    • SEC readings
spreads
Spreads
  • What’s a spread?
    • the difference between the bid (buying) and ask (selling) prices set by the market maker.
  • A spread is positive when ask > bid and negative when bid > ask
  • Size of spreads reflects
    • extent of information asymmetry
    • cost of holding inventory
    • return to market makers’ human capital
slide3

The effect of spreads on volume and prices

$

Demand

Supply

Ask

deadweight loss

P*

Bid

Volume

Q**

Q*

Quantity purchased = Quantity sold

slide4

Setting spreads to build inventory

$

Demand

Supply

Ask

P*

Bid

Volume

Q

Q

Q*

S

P

Quantity purchased > Quantity sold

slide5

Setting spreads to cut inventory

$

Demand

Supply

Ask

P*

Bid

Volume

Q

Q

Q*

P

S

Quantity sold > Quantity purchased

slide6

The effect of information asymmetry on demand and supply

$

Demand

Supply

Ask

P*

Bid

Volume

Q**

Q*

Quantity purchased = Quantity sold

slide7

Lee: 1

  • Accounting is an artifact of civilization: it exists to serve human needs
  • Accounting activity is a social system
    • objectives are defined by social needs
    • carried out by specialized agents (professionals in modern terminology)
    • education and training requirements keep increasing as objectives become more complex and sophisticated
    • rights and obligations of agents defined by society
slide8

Lee: 2

  • Business became more complex, more sophisticated concepts were needed: what attributes to measure?
    • What’s the goal? Decision making vs. performance evaluation vs. stewardship
  • With separation of ownership and control performance evaluation (profit earned) became crucial -- focus shifted to I/S.
  • Stewardship still important -- B/S retained.
  • Accrual accounting seen as incomplete, Cash flow statements acquire usefulness
sunder 1
Sunder: 1
  • Accounting standards are political in nature, redistribute wealth and are costly to society.
  • Standards are costly
    • need a bureaucracy
    • bureaucrats’ incentives may be “wrong”
    • standards stifle innovation, preserve status quo.
  • Neither pure cost-benefit analysis nor Pareto-optimality is likely to be a useful crieterion on its own.
sunder 2
Sunder: 2
  • Optimal level of standard setting trades off both the total costs and benefits as well as the distributional impact of standards.
  • What standards would be best requires good information on costs and benefits -- can standard-setter learn these truthfully?
  • Multiple mechanisms exist to set standards
    • common law, markets, referendum, legislation, judiciary, bureaucracy
sunder 3
Sunder: 3
  • APB was responsive to user needs
    • “lack of independence” seen as a virtue
  • FASB is seen as an aggressive, overly active, costly, entrenched bureaucracy with a built-in “bias for action” and is losing support from key constituencies
  • Slow down standard setting. Markets will deal with many issues without need for standards.
lev 1
Lev: 1
  • Equality of opportunity for all investors is key to a well-developed capital market
  • Equality of opportunity comes from equitable distribution of information
  • Inequity is costly: cost of capital goes up as investors seek to protect themselves. Lower volume of capital supplied and demanded. The economy as a whole is worse off.
lev 2
Lev: 2
  • Why mandate disclosure?
    • reduce costs of information asymmetry
    • voluntary disclosure incentives inadequate (?)
  • How decide what to mandate?
    • information that investors value
    • management earnings forecasts or information that is valuable for predicting future payoffs
    • information large investors or bankers get
    • protect the interests of the least informed
lev 3
Lev: 3
  • How to measure disclosure effectiveness?
    • reduction in spreads,
    • increase in price informativeness
    • reduced returns to insider information
    • equalization of returns across comparable trading strategies
sec chapter 1 1
SEC: Chapter 1 (1)
  • SEC charter: Securities acts of 1933/34
  • 33 Act: distribution, 34 Act: trading
  • Mandate: protect investors
  • Why regulation to protect investors?
        • (Lev vs. Sunder?)
    • Financial abuses preceding (and thought to have contributed to) 1929 crash.
    • Increased direct access to investors by firms.
sec chapter 1 2
SEC: Chapter 1 (2)
  • How? Regulate disclosure not merits
  • Why? Allow innovation, EMH.
  • Structure of the SEC?
    • operational arms are called divisions
      • corporate finance, investment management, market regulation, enforcement -- lawyers
    • staff are organized in offices
      • office of chief accountant, economist, general counsel -- these are the lawyers’ accountant, economist and lawyers respectively.
sec chapter 1 3
SEC: Chapter 1 (3)
  • How the SEC speaks:
    • FRRs (financial reporting releases) -- binding
    • AAERs (accounting and auditing enforcement releases) -- who’s been naughty and what their punishment will be.
    • ISRs (international series releases) -- all about them furrin’ firms and furrin’ markets.
    • SABs (staff accounting bulletins) -- interpretations, not official positions of the SEC.
sec chapter 2
SEC: Chapter 2
  • Understand the arguments for and against raising capital from the public (going public).
  • Steps in the registration process and obligations of underwriters and management at every step. Especially note the restrictions relating to the quiet period.
  • Who or what is exempt? Know this.
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